There should be a ready-made market for a great new book
just out this month: Charles G. Koch’s "The Science of Success: How Market-Based
Management Built the World’s Largest Private Company." Academia, government,
nonprofit organizations and even much of the business world could use a
management primer that integrates economic and management principles against the
backdrop of indisputable achievement.

Koch doesn’t just read books or give lectures about
building and running a successful enterprise; he actually built one, and he runs
it. Koch is CEO of Koch Industries Inc., a star performer of a company that
boasts $90 billion in annual sales and 80,000 employees. Since the late 1960s,
Charles, his brother David and their business associates have taken the oil firm
that Koch’s father started more than half a century ago and fashioned it into a
privately held global conglomerate. It produces more "stuff" than I could
describe if I had your attention for an afternoon, including things you eat,
walk on, drink from or put in your car — oil, beef, carpet, asphalt, disposable
cups and paper towels, to name a few.

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Koch’s core premise is universal and elemental, one that
should prompt any reader to have a "V-8 moment," like the characters in the old
television commercials. That premise is this: We know what makes an economy
successful — private property; the rule of law; individualism; risk and
incentive; innovation; entrepreneurship; profit and loss; competition; and
Schumpeter’s "creative destruction." In other words, a market economy.
Why shouldn’t those very principles be the foundation of an organization’s
success? The challenge, as Koch puts it, is to "develop the mechanisms" that
allow a firm (or any organization) "to harness the power of the market economy
within the company."

Koch’s book is more than a management guide. It’s a
refresher on the critical pillars of market economics. The reader is reminded of
concepts he might have either forgotten or never learned — opportunity costs,
sunk costs, marginal utility, subjective value, comparative advantage, imperfect
knowledge and numerous others. The author admits to being greatly influenced by
some of the giants of economic scholarship, from F.A. Hayek and Joseph
Schumpeter to Milton Friedman. He attributes the success of Koch Industries to
the leadership’s concerted effort to meld management principles with the
principles of the market economy, and much of the book explains how that
translated into real-world decisions, strategies and directions that built the
company over the years.

Koch calls his resulting methodology "Market-Based
Management," or "MBM." At first blush, some readers might wonder how much of MBM
is really new, but in fact, Koch has a key insight here. Economic thinking can
add significant value even in situations that don’t involve analyzing markets.

One economist who appreciated this point was the late
Paul Heyne, who authored a college text I used to require of my freshmen
students when I was a college instructor. In "The Economic Way of Thinking,"
Heyne showed how, when you really understand economics and how economies work,
it can change the way you think about much of life.

For example, I would ask my students what it "cost" them
to attend college. Invariably, they would give me a dollar figure that
represented tuition plus room and board. But then I would ask them, "What would
you be doing if you weren’t here for four years?" (A few were there for a lot
longer). It made them realize that the "cost" of a college education isn’t just
the checks that Mom and Dad wrote, but also all the income and experiences they
themselves were not earning precisely because they were in college.
Bingo. They had discovered "opportunity cost." I’d like to think that for most
of my students thereafter, nothing ever "cost" so little again.

As another example, I explained to the students how the
concept of "sunk cost" affected my behavior. I once bought what I thought
was a "bargain" half-gallon of pecan ice cream for 99 cents and then quickly
discovered the pecans were as scarce as kangaroo wings. After consuming a single
disappointing scoop, I put the ice cream back in the freezer. Time and again,
I’d see it in there, but couldn’t bring myself to pitch it. After all, I paid a
buck for it! I wasn’t thinking like an economist. Then one day it hit me: That
99 cents was sunk. History. Nothing I could do about it. The only thing that
mattered now was the future. Since I was probably never going to eat the rest of
the ice cream, the economic thing to do was to get rid of it and make room for
something better. I never flushed anything down the garbage disposal with more
intellectual satisfaction than that ice cream.

Koch drives home that even in the for-profit business
world, where markets exert a great deal of discipline, plenty of firms really
still don’t understand the power that market principles can have in their own
operations. For instance, in looking at a private business, how many times have
you noticed excessive bureaucracy, short-term thinking, ossified decision-making
and reward structures that pay for tenure rather than entrepreneurship? How many
times have you witnessed supervisors afraid to bestow real authority on those
they supervise? And how many times have you observed a corporate culture beset
from the top down with corner-cutting on both quality and integrity?

In most cases, what poor managers need is a reality
check. If they don’t comprehend the miraculous workings of a market economy,
don’t expect them to be diligently implementing its principles within their
organization’s operation. If they’re managing as if they were Soviet central
planners, they’re probably reaping Soviet results.

The Soviet system suffered big failures even in its core
"expertise": maintaining rigid internal security. Remember when a young German
named Mathias Rust flew his Cessna 172 in 1987 across hundreds of miles of
Soviet terrain and then landed safely in Red Square? Bewildered onlookers,
including police and security forces, watched as he enjoyed a nice little
self-guided tour of the local sites. They didn’t act because they were
instructed to do only what they were ordered to do, and reacting to a Cessna
landing in Red Square wasn’t in the book. They were not allowed to be on-the-job
entrepreneurs. Koch’s MBM leads to a very different environment indeed.

Nonprofits sometimes behave more like unresponsive,
unaccountable and nonentrepreneurial government outfits than they do for-profit
firms. MBM can work well here, too, with the right leadership that knows how to
implement the spirit (and not just the letter) of MBM principles. I’m proud to
say that as I read Koch’s book, I realized that my nonprofit organization, the
Mackinac Center for Public Policy, has succeeded in great measure because of MBM-like
ideas, though that wasn’t fully apparent to me until I read the book.

At the Mackinac Center, we embrace change. We seek
continuous improvement. We don’t think anything is ever done so well that we
can’t improve it the next time. We think long-term, which often means that we
forgo some attractive but ephemeral ventures that would distract us from our
course. We employ the concept of opportunity cost so we get an accurate
perspective on what it really costs to undertake a project.

We encourage our staff to be entrepreneurial by aligning
the success of the organization to their own personal income and advancement.
Like Koch and classical economists, we believe comparative advantage really is a
key to success for both an economy and an organization, so we never promote a
high-performing colleague into an administrative dead end, as many government
schools do with their best teachers. We may be a nonprofit, but we don’t act as
if it’s a virtue to be unprofitable. If I had had Charles Koch’s book at my side
20 years ago, however, I think we’d have become successful even faster.

This review hardly covers all the bases of the Koch
formula or the MBM success stories within the Koch firm — which is all the more
reason to read the book. For readers who have never made a connection between
the market economy and the principles of organizational management, a revelation
awaits on every page. For readers who think they already know these things, the
book could well be a kick in the pants that makes them realize they have a ways
to go to actually, consciously practice what they preach.

#####

Lawrence W. Reed is president of the Mackinac Center for
Public Policy, a research and education institute headquartered in Midland,
Mich. Permission to reprint in whole or in part is hereby granted, provided that
the author and the Center are properly cited. Readers interested in learning
more about "The Science of Success" can visit
www.kochscienceofsuccess.com.